Most of us will dislike debt. It takes money from us every single month. For our home mortgage, it can be thousands of dollars a month which can be quite a significant sum of money. If mortgage is such a pain, should we use the extra savings we have to pay it down faster? Let's explore it in this article.
In Singapore, we can use either cash or CPF in our OA to pay for mortgage. The cost on a mortgage is on the interest. Like credit card which charges an interest if we didn't pay on time, likewise mortgage loans charges an interest because it is a loan in nature.
Interest payment can be in 6 figures Should we use our CPF to pay down our mortgage?
Most mortgages will start with around $250,000-$300,000 if you buy a 4 room HDB flat. The interest rate if you take up a HDB loan is 2.6% for 25 years. Did you know for a $300,000 loan at 2.6%, the total interest you would have paid is $108,181.66? If we can shorten the loan to 15 years, the total interest paid would have decreased to $62,594.59. This would immediately save us more than $40,000.
Now, if we have extra $100,000 in our CPF and our mortgage is left with $100,000, should we use all our CPF money to pay our mortgage down immediately? This may not be a wise choice. Why is this so?
Let's assume the mortgage is left with $100,000 for 10 years, total interest paid would be $13,657.79 at 2.6%. For the same $100,000 left in the CPF OA to earn 2.5%, the total interest earned would be $24,886. This is assuming we have enough monthly CPF contributions to cover the outstanding mortagge every month and will not touch the $100,000 left in the OA at all. The interest earned in the OA at 2.5% would be at least $10k more than the interest paid for the mortgage at 2.6%. Why does this happen when the interest paid on mortgage is more than the interest earned in the CPF OA? Shouldn't the mortgage interest cost be more?
The simple reason why the mortgage interest paid is lesser than the amount earned in the CPF OA is because mortgage interest is always amortised. This means the interest is calculated based on the remaining balance instead of the whole beginning balance of $100,000. On the other hand, the interest earned on the CPF OA is compounded which makes it much higher than what we thought it would be.
Should we use our cash to pay down our mortgage?
Using cash to pay down our mortgage may be a good choice. Right now, the money in most of our savings account do not earn more than 2.6% interest which is the interest of the HDB loan. Paying it down and reducing the loan tenure will save us more money. As mentioned earlier, it can be as much as $40,000 savings just by reducing the loan tenure by 10 years on a $300,000 mortgage. However, paying down cash means we have lesser cash flow for emergency or anything which you need the money for. It is always important to plan in advance before using cash to pay down our mortgage especially when its a huge sum of money.
There are various ways to save on the interest we pay on our mortgage. We can reduce the loan tenure which means paying more per month for our mortgage or we can pay lump sum every year to reduce our mortgage amount. We can also refinance to a better package which is lower than 2.6% or any lower interest rates. Many banks actually offer loan packages which are less than 2% now.
A lack of understanding of how interest rate works will make us poorer. Compound interest works its magic while amortisation on housing loans means interest paid is lesser than what is shown. For other loans such as car loans or credit card debt, the wisest decision is to pay it off or even better don't take any of such loans or owe the credit card company any money. Car loans are not amortised and is different from housing loans so the interest paid is always much more than housing loans. Credit card interest is even more scarier as it compounds at a very high rate. Have you made the right decision today?
